Retiring from the military brings many changes to a family. Children can start making more lasting relationships at school. Spouses who bore the brunt of child-rearing and household chores can become more career-focused. The family member who wore the uniform of the United States each day must now actually decide what to wear to work! In all this upheaval, it is easy to forget about taxes. Unfortunately, failing to plan and take action for taxes after retirement can have costly consequences. Below are the five most common errors I see military retiree families make in their first year after transitioning out of the service.

1. State Taxes. The Servicemembers Civil Relief Act (SCRA) and its many amendments prevent a state from taxing military personnel and their spouses just because they are serving on orders in that state. The SCRA effectively provides some beneficial safe spaces from state income taxes. Consequently, many military families do not pay state income taxes while on active duty. After retirement, that good deal stops. As a civilian, if you are living and working in a state with an income tax, that state is going to expect you to pay income taxes on the money you earn. That goes for spouses as well. On top of that, many states will also tax all or part of military retired pay. If you do not have sufficient state income tax withheld from your family’s various pays, then you can expect a hefty state income tax bill at the time you file, along with penalties and interest for not having enough withheld in the first place.

2. Under Withholding. Most military retirees roll quickly into career 2.0. Accustomed to long hours of hard work, they ‘hit the ground running’ at their new job. Spouses will often become more career-focused as well, snapping up better jobs knowing they will not have to move in a year or two. When military retired pay is added to the mix, there are now at least 3 significant paychecks coming into the house. While this is a good thing for the family’s financial health, it can create a tax issue unless the wage earners take some action. The issue arises because each of the sources of income is not aware the family has multiple sources of income. DFAS does not know that both the retiree and spouse have income. The spouse’s employer is not aware the retiree has a job and a pension. The result is they withhold as if there was only one source of income, which will not be enough to cover the tax owed. Let’s look at an example. For simplicity, let’s assume the retiree and spouse each earn $50,000, and the retirement income is also $50,000. From the perspective of DFAS and both employers, it looks like the family is earning a total of $50,000. This would put them in the 10% tax bracket, so DFAS and each employer withholds 10% of pay for federal income taxes. When the family files the tax return and totals all their income, they actually earned $150,000, putting them in the 22% tax bracket. They have significantly under-withheld taxes and will be facing a large tax bill at the time they file their returns.

3. State Tax Breaks for Military. The secret is out, military retirees make good residents. With that in mind, many states are offering tax breaks on military retired pay, and more states are joining the party all the time. Virginia began phasing in a subtraction (Virginia calls some deductions ‘subtractions’) for military retired pay in 2022. Unfortunately, many taxpayers and even some tax professionals are not aware of these tax benefits for military retirees. If your state offers a tax break for military retirees, make sure you are taking advantage of it!

4. Personal Property Tax Deduction. Many states levy a tax on personal property such as cars, trucks, campers, and boats. Military personnel rarely pay these taxes while they are still serving. Like the break on state income taxes, the good deal on personal property taxes also ends upon retirement. What many retiree families fail to realize, however, is that those personal property taxes are deductible from state and federal income taxes for taxpayers who itemize their deductions. Even if a family does not itemize deductions, including personal property taxes on the tax return can have a small positive benefit on the taxability of future state income tax returns. If you are paying personal property taxes, make sure your tax preparer is including them when preparing your tax returns.

5. Contributions to Roth IRA when over the Income Limit. I am a huge fan of Roth IRAs. They are a great vehicle for retirement savings. I am always encouraged when I see military families planning for their future by contributing to a Roth IRA. That is, unless they no longer qualify to make a direct contribution to their Roth IRAs, which often happens to newly retired military families. For all their goodness, Roth IRAs come with an income limit for contributing money to them. Retirees will frequently take a job paying more taxable income than their military job. Spouses often increase their earnings, as well. Add to that the military retired pay, and it is likely to put a military retiree’s family over the annual limit for direct contributions to a Roth IRA. The people who wisely set (and forget) their Roth IRA contributions to be paid automatically each month while on active duty often find themselves having made unlawful contributions after retiring from the military. These excess contributions are easily corrected (for free) if you catch them yourself. If the IRS catches them for you, fixing them comes with a price tag in the form of taxes and penalties. If you are contributing to a Roth IRA, verify you are under the contribution limit before you do! (The modified adjusted gross income limit for Roth IRA contributions in 2024 is $161,000 if you are single and $240,000 if you are married and file jointly. The amount you can contribute may be reduced at lower income levels.)

Retiring from the military provides a significant amount of financial flexibility to families. The combination of guaranteed income from a pension and low-cost health insurance is a potent combination. Many families leverage that combination to new levels of prosperity. If you are in that position, enjoy it. You earned it through decades of hard work. Just be careful not to let the taxman bite you on the boot in retirement. Plan for your new tax realities, and if you have questions consult with one of the tax professionals at the Military Tax Experts Alliance.